Why You Need A Written Operating Agreement For Your LLC
By Lane V. Erickson, Idaho Business Attorney
This article assumes that you’ve already chosen to operate your business under Idaho law through a limited liability company also known as an LLC. If you haven’t yet made this decision, or if you aren’t certain whether an LLC is the right entity for your small business, please read the other articles we have on this website about how an LLC can help and protect you and your small business.
The purpose of this article is to discuss why you need a written operating agreement for your LLC to make sure that it operates exactly how you want it to. In other words, this article will discuss how having a written operating agreement gives you the ability to control everything about your business allowing it to operate efficiently and smoothly.
At the Racine law office, we have assisted clients for more than 70 years in creating Idaho business entities, including an LLC when this option became available in the mid-90s. We help our clients structure their LLC, and we help them make important decisions concerning how their business will operate. One of the most important things we do is we help our clients create a written operating agreement that is then signed by all the owners of the business.
An operating agreement is like a roadmap for how the business will operate. It is a contract between all the owners who signed the agreement. Additionally, if the other owners want to allow an additional owner to come into the business, the operating agreement controls how this happens and operates to bind the new owner the same as the previous owners.
Because it is a contract, the operating agreement can be amended, revised, or changed anytime all of the owners agree to do so. This new agreement would also be in writing and would specifically state that it’s replacing the old operating agreement.
This all sounds well and good, but it doesn’t really answer the question about why you need a written operating agreement in the first place. This article is going to discuss the four main reasons why having a written operating agreement is important. Keep in mind that this article is just a short summary of the applicable law and reasons of why having a written operating agreement is important. If you have additional questions, we encourage you to contact us for a free 30-minute consultation where we can answer your questions and help you understand the importance of a written operating agreement for your Idaho LLC.Remove the Default Statutory Operating Agreement
The first and perhaps most important reason for having a well-thought-out written operating agreement is that it removes the default statutory operating agreement that exists. Idaho’s LLC statutes found at Idaho Code § 30-25-101 et seq., creates a default operating agreement for any Idaho LLC that doesn’t have its own written operating agreement.
The default statutory operating agreement may not provide the structure for your LLC business that you or the other owners of the LLC want to follow. However, until you have a written operating agreement that is signed by all the owners, the default statutory operating agreement controls. This is why when you create an LLC it is better to prepare a written operating agreement at the start of the business rather than trying to adopt one after the business has already been operating.Identify Owners and Percentages of Ownership
One of the main purposes of having a written operating agreement is that it provides the business with an opportunity to identify who the owners are, and the percentages of ownership that each owner holds. This is important because the written operating agreement can also provide voting rights for the owners of the LLC based on their percentages of ownership.
In other words, if a major decision needs to be made for the business and all the owners can’t agree on how to move forward, the decision will likely come down to a vote of the ownership interest of the owners. The operating agreement can describe the process for taking this vote. Additionally, the operating agreement can also describe whether the vote will be decided by a pure majority or some other required percentage of owners.Establish Management of the Business
When there is no written operating agreement the statutory operating agreement provides that management of an LLC is vested equally in all the members of the LLC. In other words, all members of the LLC have an equal right to make business decisions and manage the business. When there is more than one member of the LLC and a decision needs to be made about how to manage the business, then the decision will be made by a majority of the members.
When there is a written operating agreement the owners of the LLC can choose to retain the “member-managed” option or they can choose something different. Specifically, in a written operating agreement the owners of the LLC can choose to have a “manager-managed” LLC or an LLC that is “managed by managers”. In other words, you can choose one person to manage the company who has the rights to make all the decisions of the business or you can include more than one manager. When there is more than one manager than decisions are made by a majority of the managers.Control Transfers of Ownership
Perhaps one of the most important ways that an operating agreement can protect an LLC is by controlling how transfer of ownership will occur. Even when operating a business, the realities of life continue to happen. This could include having one of the owners of the business died, become disabled, get divorced, or simply decide that they no longer want to be part of the business. Any one of these events can lead to a transfer of ownership in the LLC.
An ownership interest in the LLC is considered personal property by the person who owns it. Because of this, this person can transfer their ownership interest by a gift, or through a last will and testament if they were to die, or by selling their interest to some third party. Additionally, in a divorce proceeding, a court could determine that a portion of the ownership interest an owner has in the LLC belongs to the owner’s spouse. Because of this, the operating agreement may be a necessary tool to control how and when these transfers occur.
Additionally, and operating agreement can provide to the other owners of the business, or to the LLC itself the first right to purchase these ownership interests back from the owner so that they can maintain control over who they are in business with. Even when the ownership interest cannot be purchased from the third party, the operating agreement can limit the control, management Rights, Voting Rights, and so forth that the new outside owner has in the operation of the LLC.
There are many reasons why written operating agreement is vitally important for your Idaho LLC. We have helped numerous business clients create an operating agreement for their LLC, and we are confident that we can help you too. Please contact us with any questions you have.Enlist an Idaho Business Attorney To Help You
Our team of Idaho business lawyers can help you with any of your business structure or operation needs. Whether you are seeking to create a new business or review a current business, we are available to discuss your options and answer your questions at an initial free 30-minute consultation. Call us toll free at 877-232-6101 or 208-232-6101 for a free consultation. You can also email us directly at firstname.lastname@example.org or stop by our office at 201 East Center Street, Pocatello, Idaho 83201. We will answer your questions and help you solve your Idaho business problems.